Remarks of Thos. E. Capps
Chairman & CEO - Dominion
at the
Deloitte Energy Conference
May 24, 2004
"Why We Need A National Energy Policy"
Good morning.
It's a pleasure to be here… and a privilege
to join Chairman Wood for a discussion about national energy policy.
Just a few weeks ago, I would have asked, "What
national energy policy?"
I was firmly—and uncharacteristically—in
the gloom and doom camp.
Legislation was stalled in Congress. Prospects
for forward progress appeared slim to none. Bickering over side issues torpedoed
every effort to pass a comprehensive energy bill. Election-year politics made
lawmakers shy away from doing anything decisive. All this, despite the urgent—and
all-too-apparent—need for action.
About 50 million people were blacked out by the
power failure last summer, and they didn't see fit to pass a comprehensive energy
bill? I asked myself, what would it take?
I figured the blackout—and the reliability
concerns it raised—had become repressed memories.
It looked like legislators had somehow forgotten
the need to improve the energy infrastructure…and that "energy security"
had been relegated to a convenient campaign slogan. It also seemed that our
unhealthy dependence on foreign sources of energy—made riskier by the violent
path of recent events—would never change.
I was tempted to dust off a speech I gave three
years ago to a group of economists here in Washington. The topic was none other
than national energy policy—or the lack of it.
I complained loud and hard about the inability
of Congress to pass anything. I compared the energy infrastructure to a critically
ill patient, suffering from clogged arteries, cardiac insufficiency…and
self-inflicted wounds.
I'm afraid the patient is still sick.
But this morning, I'm happy to report, there
may yet be a pulse—and even a few glimmers of hope.
We're still a long way from a remedy—namely,
a comprehensive strategy for meeting the energy needs of the American people
in a secure and reliable way.
But the blockage may be breaking up. Contrary
to my fears, the magnitude of the problem may be too big for even the most timid
legislators to ignore any more. I think high gasoline prices may have their
attention right now.
On May 11, the Senate took the tax portion of
the old comprehensive energy bill, hooked it to another piece of corporate tax
legislation, and passed the package by a decisive 92-5 margin.
Finally, some legislative creativity!
As you might imagine, those of us in the energy
industry strongly supported this move.
The tax bill does good things:
It promotes development of a new natural gas pipeline to
transport gas from the Arctic fields of Alaska;
It provides incentives for the use of clean-coal technology
to produce electricity;
It encourages energy efficiency by giving new tax breaks
to contractors building energy-saving homes;
It promotes fuel diversity by offering incentives to individuals
who buy wind power and to businesses purchasing fuel-cell power plants;
And it reinstates the vital "Section 29" tax
credit for the production of oil and gas from wells drilled in difficult geological
formations, such as tight sands, devonian shale and coal-bed methane. This
tax break means a lot to Dominion. Many of our gas wells in Appalachia and
the Midwest are drilled in such formations. The tax credit is a big "win"
for domestic energy production. Without it, many wells in the U.S. simply
wouldn't be viable.
Here's another glimmer of hope. Before passing the tax bill,
the senators approved an amendment that should give a boost to that much needed
infrastructure improvement—the construction of new transmission lines.
The amendment reduced the depreciation life of transmission assets by one-fourth—from
20 years to 15 years.
Unfortunately, the amendment was modified to apply only to
new facilities entering service before June 30, 2006. That time limitation should
be removed, either in the House or in conference committee. Lawmakers need to
restore the open-ended tax break for transmission that was in last year's House
version of the energy bill.
Overloaded transmission lines are like clogged arteries. They
threaten transmission integrity. Without decisive action, the situation will
deteriorate. With no new incentives, spending on transmission construction is
expected to increase by only six percent over the next decade—less than
one-third the rate of the growth of demand.
I congratulate the Senate for taking action. I also realize
the bill is a long way from becoming law. It's late in the legislative season,
and Congress probably can't resist the urge to get out of town early in an election
year.
We can only hope the House will recognize the wisdom of the
Senate's action and pass the tax bill promptly so it can be on the President's
desk soon.
In case you were starting to worry, that's the extent of the
good news. Let's sink back into gloom and doom for a few minutes.
Truth is, comprehensive energy policy still lies in legislative
limbo. The tax bill wasn't even half a loaf…maybe an eighth, maybe a fourth,
if you're an optimist.
Sure, tax breaks are important—but we still need a comprehensive
energy policy. And after years of trying, we're not there yet.
So in the words of the Nike ad I say to Congress, "Just
do it!" Finish the job! Stop bickering! You've been studying this for years.
How hard can it be?
With a comprehensive energy blueprint, our industry—and
our nation—will be better armed to mix it up with the same old opponents
to energy security and reliability: spineless politicos, NIMBY activists, radical
environmentalists, turf-conscious regulators (present company excluded), and
anti-American regimes sitting on billions of barrels of crude oil.
The various bills considered—and shelved—by Congress
in recent years contain the key elements of a successful energy policy.
The first one's easy: We need to improve the reliability of
our transmission systems.
After the blackout last August, I sent a letter to members
of Congress. I suggested four measures for bolstering the transmission system
and ensuring the lights don't go off over a big chunk of the continent. Some
of these steps are in one or more of the discarded bills. I'd like to see all
of them in the final product.
First, the time for voluntary compliance with reliability
rules has passed. We need binding federal standards for grid operation and a
national organization such as FERC to enforce them. To my way of thinking, this
falls in the category of "no brainer." It's been part of every so-called
"comprehensive" bill to come down the pike.
Second, the federal government should have a hand in making
sure vital electric transmission facilities get built…in a timely manner.
Regulatory oversight of the transmission system is currently shared by FERC
and state regulatory bodies. This arrangement is a holdover from the days when
there was little or no interstate commerce in electricity.
The problem is, the game has changed. The transmission system
is now being used to buy and sell power in larger, regional wholesale markets
that don't respect state boundaries. Yet the responsibility for siting power
lines still rests with the states. And their rules for approving new lines vary
widely. That means individual states have the ability to "just say no"
and kill or seriously delay a multi-state project.
As Dominion's utility neighbor to the west, American Electric
Power found out, years—even decades—can go by when a proposed line
crosses multiple jurisdictions and each one has to bless the project. Eleven
years later, the line still hasn't been built.
Imagine a state telling the federal government, "Sorry,
you can't build that interstate highway. We don't want people driving through
here to get to the West Coast." That's the situation companies face when
trying to site new power lines across multiple jurisdictions.
It's time for the FERC to have the same role in siting electric
transmission lines as it has in siting gas transmission lines. High-voltage
lines are part of interstate commerce. Moving electricity from place to place
is a national business. Large, multi-state transmission projects should be subject
to federal eminent domain powers.
State commission foot dragging, or worse yet, local opposition
from those with the "Not on Planet Earth" approach too often prove
fatal to desperately needed infrastructure projects.
Third, we need more financial incentives to build transmission
projects. The profits currently allowed for owning and operating transmission
networks are tightly regulated by FERC—and less than allowed returns on
other types of infrastructure investments. The risk of devoting years of time,
capital and sweat equity to propose, site and build a giant, multi-state power
line is not offset by the potential financial reward.
The Edison Electric Institute, an industry trade group, estimates
that investment in new transmission has dropped by more than $100 million a
year for the past 25 years. That should come as no surprise when it takes more
than 20 years on average to get your money back.
Bottom line: Power line expansion and construction is a risky,
complicated business. Those who assume the risks should be compensated proportionately.
Until higher returns on investment are allowed, adequate capital simply won't
flow to these projects.
The accelerated depreciation is a good start…but just
a start. An effective package would include new rate structures to promote much
needed capital investment.
Finally on the reliability front, Congress should mandate
regional transmission organizations. Down south, where I come from, RTOs tend
to be viewed as something akin to the second coming of General Sherman. They're
a federal threat to the states' rights.
Call me a federalist or a traitor to my roots, but I'm a firm
believer in RTOs. They do the planning needed to ensure we have adequate transmission
and generation facilities over broad, multi-state areas. They're vital to the
success of a competitive marketplace, both wholesale and retail. I wish more
of our state commissions shared that view.
A clear signal from Congress that if states don't act within
a finite amount of time, sole jurisdiction moves to FERC. That might produce
a helpful adjustment in attitude. Many southern states have never accepted the
fact that we lost the Civil War and are still fighting it—but on a different
front.
President Eisenhower never could have gotten our interstate
highway system built if every village, Middlesex or farm could have halted construction.
Our transmission system should resemble the interstate highway system, where
electrons can move easily from place to place.
The press talks about a "national grid." There is
no national grid like they have in the UK—but there damn well should be.
Our problem has its roots in the provincial mindset that governed our original
build out.
Under cost-of-service regulation, utilities built their transmission
systems to serve only their own customers. There may have been a point or two
where there was an interconnect with a neighboring utility so a few hundred
megawatts of power could be bought or sold to protect against unplanned generating
unit outages. Individual systems were not—and still aren't in many cases—designed
to move large blocks of power over long distances.
That's my prescription for fixing the ailing veins and arteries
of our patient.
But that alone won't restore complete health. There's still
what I termed "cardiac insufficiency." We have to boost energy production.
Congress can and must make this happen.
First, let's put the nuclear and coal options back on the
table. Three years ago I said the nation faced a dangerous fuel imbalance in
power generation. New gas-fired plants were popping up like mushrooms all over
the country. Virtually no new coal units—and absolutely no new nuclear
units—were even being contemplated.
Not much has changed. There are some modest tax incentives
for coal in the Senate's tax bill. And a few companies—including Dominion—are
taking a very preliminary look at nuclear construction to see if it might be
feasible down the road. But on both fronts, development remains virtually comatose.
Here's my wish list for kick-starting both sectors.
We've got to recognize that nuclear energy has a place in
the mix. It supplies one-fifth of the nation's electricity and produces zero—yes
zero—emissions. The industry has a sterling safety record and continues
to excel in performance.
Last year, Senator Domenici, chairman of the Energy and Natural
Resources Committee, repeatedly emphasized that strong nuclear incentives belonged
in a comprehensive bill. Somewhere along the way, most of these provisions were
dropped. Let's put them back in.
For example, at one point the Senate version of the bill used
financial incentives, such as loan guarantees, to support construction of new
nuclear stations. A good first step, but much more will be needed.
To build a new nuclear plant today would take a minimum of
six-and-a-half years and more than $2.5 billion, financed on a 50/50 equity
basis.
That means over the six-and-a-half-year construction period,
the company would have to borrow and pay interest on $1.25 billion and issue
$1.25 billion of new common equity. Until the plant was up and running, it would
produce no income to service the debt or earnings for the common equity.
If you announced you were going to build a new nuclear plant,
Moody's and Standard & Poor's would assuredly drop your bonds to junk status.
Hedge funds would be bumping into each other trying to short your stock.
In my opinion, no company in our industry is large enough
to take on this risk. Several companies, including my own, have banded together
to look at it. While I believe in trying to keep all options available, Dominion
has absolutely no plans to build a nuclear plant at this time. The intentions
of these consortia are commendable. Their ambitions are, in my opinion, unrealistic.
I'm all for nuclear power—as long as Dominion doesn't
have to take the risk of building a new nuclear unit. Before new plants are
built, I think the federal government or some large company such as GE will
have to build them and take on the construction and financial risks.
Even then, a nuclear unit financed with 50 percent debt and
50 percent equity with a 15 percent return on equity would have a buss bar cost
of around $51.17 per megawatt-hour. Last year, a plant with that cost of production
in the PJM Interconnection would have run only 700 hours. The numbers just don't
work.
Still on the nuclear front, we should re-authorize the Price-Anderson
Act. It shields nuclear generators from catastrophic damage claims. Without
Price-Anderson, it would be damn tough to operate nuclear stations. Last year's
House and Senate bills—as well as the conference report—also re-authorized
the Act.
The cost of constructing nuclear plants—even if the government
would build and finance them during construction—will have to come down
before we see new nuclear plants.
And it's time to come to grips with the high-level waste issue.
My message to Congress and the regulators on Yucca Mountain is simple: Get off
your rear ends! Federal law should require the Department of Energy to fulfill
its obligations by a date certain.
Dominion, for example, has paid the federal government $633
million for storage—and gotten nothing in return. I'd like to tell DOE,
at least give us our cost of capital on that money—or give it back if all
we can expect is more foot dragging.
As for coal, it supplies more than half of the power consumed
in the U.S. Unfortunately, a lot of politicians, environmental activists and
much of the press delight in bad-mouthing it. The power industry hasn't helped
by failing to counter the jabbering with the sound science we know exists.
With today's technology, we can build coal plants that are
clean and protect the environment. Congress has to figure out a way to promote
construction of modern, environmentally friendly coal-powered units.
One helpful measure would be a required cost-benefit analysis
of environmental regulations—before they go on the books. That would improve
the chances of federal energy officials and the EPA following the same play
book and not going off in different directions.
A comprehensive bill could require all states to create a
one-stop siting board—or lose funds if they fail to comply.
We should be promoting market-based approaches to compliance,
such as expanded emissions trading. Some environmentalists turn up their noses,
but trading programs produce dramatic emissions reductions. What can I say—some
bureaucrats are threatened by things they can't control—like the free market.
And let's not forget zero-emissions hydro power. It takes
seven years or better to license or re-license these facilities. We need to
streamline this process so hydropower remains a significant part of domestic
energy supply. I have a lot of respect for our friends at FERC, but in the past,
on occasion, they've been slow as molasses.
Americans also have a right to energy legislation that promotes
domestic oil and gas production—and helps free us from dependence on unstable
supplies from volatile parts of the globe.
About the only power plants that can be built today are fired
by natural gas, but this country is running out of gas.
Last year, we consumed about 20 trillion cubic feet of natural
gas. Gas wells in the Gulf of Mexico are declining at an annual rate of 37 percent,
and across the country at a 27 percent annual clip.
In other words, our decline rate is 5.5 TCF per year. Add
that to an annual demand growth of .6 TCF, and we're going to need 6.1 TCF in
new gas production per year. Over the last 5 years, average incremental production
amounted to 4.5 TCF. That leaves us with an annual shortfall of about 1.6 TCF.
Drilling rig count remains high, but the average rig is finding 25 percent less
gas than a year ago. In Canada, it's even worse.
Congress must force the Bureau of Land Management to open
up more acreage for drilling in the West. According to the National Petroleum
Council, access to these supplies could save consumers hundreds of billions
of dollars during the next 20 years.
My company is lucky. We have well over one million acres of
drillable land. For the past two years, we have drilled more wells than anyone,
including the majors. This year, we will drill more than 1,000 wells.
Incentives in the tax bill for production in "non-conventional"
settings represent a valuable step forward, but they're not the only ones needed.
We need steps to facilitate construction of long-distance
gas and oil pipelines to haul both raw materials and refined products.
We also need a strong dose of realism. We will never wean
ourselves from foreign supplies—especially with the demand for natural
gas outstripping our ability to produce it domestically.
So let's accept that fact and not run out of natural gas.
We need to develop more liquefied natural gas import facilities.
Right now, LNG supplies about 2 percent of the gas consumed
in this country. By 2015, that figure will have to approach 20 percent to meet
demand. To get there, four new LNG terminals will have to be built. That's in
addition to planned expansions at three of the nation's four existing terminals,
including Dominion's Cove Point facility on the Chesapeake Bay. The other three
import terminals are located in Massachusetts, Georgia and Louisiana.
If you read either The Wall Street Journal or The New York
Times a week ago Friday, you can understand the problems with siting new LNG
facilities. Of the 30 or so that have been mentioned, we'll be lucky to get
three or four built, in my opinion.
And let's also clear up any lingering doubts that FERC—not
the states or the localities—should have siting power over LNG terminals.
LNG could go a long way to satisfying our country's growing
appetite for natural gas—but only if we can expand our LNG infrastructure.
Lawmakers must show their support for natural gas imports. Regulators must streamline
the permitting process. Investors need assurance they can expect a reasonable
return on invested capital. And public concerns about safety and security must
be thoroughly addressed.
Finally, a federal energy bill should let the markets do their
job. I know that concept threatens many folks in government. But that's fortunately
not the case with our distinguished guest, Mr. Wood. He's well aware of the
role markets play in promoting robust supplies and economical prices.
Others haven't caught up with his thinking. Too many regulators
still believe markets and the public good are incompatible. I suggest they take
another look at "cost of service" regulation—and the huge inefficiencies
this outmoded model promotes.
This won't be easy. There are tough state-federal turf issues
in play here. Again, I'll put on my federalist hat. Most people think an adequate
supply of electricity is a God-given birth right. When you flick a switch, the
lights should come on. As we know from the blackout last summer, this is not
a local or state problem—it's a national one.
A federal energy bill should take steps to ensure that rates
provide incentives for investment…that ratemaking serves to balance supply
and demand and promote efficiency—not the "if you build it, they will
pay for it" thinking embedded in the cost-of-service mentality.
Congress can also free our industry from some of the illogical
and outdated regulations hobbling our ability to make sound business decisions—on
behalf of our customers and our shareholders.
PUHCA, the Public Utility Holding Company Act, is a perfect
example. This Depression-era law undermines competition, stifles innovation
and hurts our sector's efficiency.
When PUHCA was enacted in 1935, the state of our Republic
was dire. We were still in the grips of the Great Depression. No other legal
framework existed to oversee the holding company structure. The law served a
legitimate purpose back then. But to paraphrase W.C. Fields, it made the mistake
of living too long.
Today, other regulatory and statutory authorities protect
consumer and investor interests. The FERC and state agencies regulate utilities.
The SEC oversees securities functions. The FTC and the Justice Department have
plenty of muscle to monitor the market. And abundant market information is available
to anybody who wants it.
Moody's and Standard & Poor's were asleep at the wheel
when Enron and others were plying their trade. Now they have awakened with a
terrible resolve. In my opinion, they are more involved in trying to atone for
past mistakes and playing the "C-Y-A" game than they are serving the
bond markets as they're paid to do.
Tougher accounting standards and disclosure requirements are
in place. Eager prosecutors stand ready to punish the wicked. In my view, the
free market does a much better job of punishing offenders and misdeeds than
regulation does.
For 20 years, the SEC itself has been calling for PUHCA repeal.
Agency Commissioners have told Congress repeatedly it's the most burdensome
regulation they have to administer.
SEC Commissioner Isaac Hunt told the Senate Energy Committee
two years ago—quoting here— "Repeal of the Act would… eliminate
any impediments that exist to other regulators' attempts to modernize regulation
of the utility industry."
No credible industry observer disagrees.
Let me share some real-world statistics from my own company.
In our accounting department, for starters, 19 professionals
spend about 4,000 hours each year making sure we don't run afoul of the Act's
endless do's and don'ts. About the same number of otherwise productive people
in our legal, treasury, corporate secretary and external affairs groups burn
another 1,500 hours on the same task. Beyond that, we can routinely count on
adding about two percent of additional time for outside and inside legal work
on each financing and acquisition we undertake. That's big money in a world
of multibillion-dollar transactions.
As Milton Friedman at the University of Chicago taught us
a long time ago, heavy-handed regulation equals heavy-handed taxation. Both
are bad for the economy.
In my view, our industry stands to benefit by having smaller
numbers of large market cap companies with deep pockets and strong liquidity
as business conditions become more challenging.
With PUHCA blocking the way, our industry can't evolve into
a sector where a handful of big market-cap players will confront and master
those challenges. Our industry has a total market capitalization approaching
$1 trillion—yet we are the only industry that size without large players.
Big players—the WalMarts, the CitiCorps, the ExxonMobils—with
better access to capital and better operating efficiencies can manufacture and
sell their products cheaper than less efficient entities. Big players also can
afford R & D budgets aimed at future consumer well-being. Our industry's
expenditures on R & D are somewhere between lousy and non-existent.
If there was ever an industry that could benefit from R&D,
it's ours. Neither generation nor transmission technology has developed much
since the late 1940s. Imagine the environmental breakthroughs we might achieve
in emissions controls… or by bringing solar and wind power along to more
rapid commercial development.
As it stand today, our top three market-cap players—Dominion,
Exelon, Southern—hang in the neighborhood of $20-plus billion—peanuts
compared to leaders in other industries.
Along with PUHCA repeal, we desperately need PURPA reform.
The Public Utilities Regulatory Polices Act is a relic from the Carter era.
It was a dumb Act then, and it's an even dumber Act now. It has been an albatross
around the neck of the electric power industry since its inception. The "must
buy" provisions have forced utilities to sign contracts with above-market,
inefficient and uneconomical independent generators and have put the screws
to the purchasing utilities' ratepayers.
We're doing our best to get out from under these contracts.
Congress could make the future a lot brighter by repealing the "must buy"
provisions and freeing utilities from the burden of buying power from such units
in the future.
Will any of this come to pass? The gloom and doom side of
me doesn't hold out much hope. It's an election year, after all.
But as I said earlier, there are glimmers of hope. The passage
of the tax bill would be a good start. It makes many vitally needed reforms.
It shows the gridlock can be broken.
We have a great opportunity before us to take decisive steps
to promote a reliable and secure energy future for our nation. In today's world,
which is often unreliable and insecure, it's an opportunity we shouldn't pass
up.
If we don't get the job done, things will not get better,
energy prices will continue to rise, and we will suffer the various adverse
effects that rising energy prices have on our economy and our way of life.
